Electricity and gas rates are one of the most important components in managing costs for any company to earn more business efficiency.

Within the range of options offered by energy retailers, indexed rates are presented as an alternative that can be very attractive to certain consumer profiles. However, understanding how they work and if they're right for your business requires a detailed analysis.

In this article, we'll explore in depth what indexed rates are, how they operate in the energy market, and how to determine if they're the best option for your business.

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What are indexed rates?

Indexed rates are those in which the price the consumer pays for energy is linked to a reference index, such as the wholesale electricity market or the gas futures market. This means that the cost of energy varies depending on market fluctuations, in contrast to fixed rates, where the price remains constant during the contract period.

In simple terms, with an indexed rate, the price of the energy you consume is not fixed, but is subject to market changes. This can be advantageous in certain scenarios, especially when the price of energy in the market falls, as your company could benefit from these declines.

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How do index rates work in marketers?

Energy retailers offer indexed rates as an option for consumers looking to take advantage of potential price drops in the energy market.

In an indexed rate, in theory, the final price paid by the customer is made up of two main parts:

1. Wholesale market price:‍

This is the price that is determined daily in the wholesale electricity or gas market. This market operates based on supply and demand, so the price may vary every hour of the day.‍

2. Merchant margin:‍

This is an amount added by the marketer to cover its operating costs and obtain a profit. This margin is added to the indexed price of the wholesale market.

However, this margin does not apply in the same way to all marketers. In fact, marketers have a variety of ways to structure their trading margin, which can make it difficult to understand and compare indexed rates.

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The complexity of indexed rate formulas

A marketer has several ways to apply their business benefit to an “indexed” contract.

In some marketers, the formulas for calculating the price of an indexed rate may include several additional coefficients and concepts. These can vary considerably from one retailer to another and are not simply a “simplification” of a more complex formula. Each marketer has its own calculation mode, which complicates direct comparison between them.

The “classic” way is to apply an indexation margin to the energy cost price (1), (cost price + profit of the marketer).

But you can also apply a margin to the billing price of the contracted power (2).

Another way is to apply a margin through a specific concept such as “management service”, “service cost” (3).

Sometimes marketers apply a combination of these margins (5), but we found marketers who applied all 3 at the same time, communicating only about the indexation margin (1) to their clients.

Example of how additional costs affect the cost of your final indexed rate

Take the case of Comercializadora A, which reports a trading margin of 0.6 c€/kWh. This might seem attractive compared to Comercializadora B, which has a commercial margin of 1 c€/kWh. However, when analyzing the additional costs applied by Comercializadora A, such as the operating cost (CO) of 0.83 C€/kWh and the financial cost (CF) of 0.25 C€/kWh, these amount to 1.08 C€/kWh, which exceeds the commercial margin of Comercializadora B, which does not add additional costs.

This raises an important question: Are marketers being transparent when reporting their rates? From a technical point of view, they are not lying, since the operational and financial costs are real and are related to the purchase of energy. However, these costs are internal to the marketer and can vary widely from one company to another, making direct comparison between rates even more complicated.

How does this affect your company's decision?

Since the formulas and additional costs can vary so much between retailers, making a direct comparison between different indexed rates is difficult. What seems like an attractive offer at first may not be so attractive once you consider all the hidden costs. Therefore, if you are considering opting for an indexed rate for your company, it is crucial to do a detailed analysis and, if possible, to consult an energy expert.

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Benefits of indexed energy rates

Index rates offer a number of advantages that can make them attractive to certain types of companies:

1. Potential economic savings

If the price of energy in the wholesale market falls, an indexed rate allows companies to benefit from these declines. In times when the energy market is in decline, companies can significantly reduce their costs compared to a fixed rate.

2. Adapting to market fluctuations

Companies that are familiar with energy market behavior can take advantage of price fluctuations to plan their consumption, maximizing periods of low prices.

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Disadvantages of indexed rates

Despite the advantages, indexed rates also have disadvantages that must be considered:

1. Risk of high prices

The main risk of indexed rates is that if the price of the wholesale market increases, the cost of energy to the company will also increase. This risk of volatility can lead to unexpectedly high bills, which could affect the company's financial planning.

2. Difficulty in forecasting costs

Since the price of energy fluctuates, it can be difficult for companies to forecast their long-term energy costs. This can complicate budgeting and financial planning.

3. Requires constant monitoring

Companies that choose indexed rates must be willing to regularly monitor the energy market. This may require additional time and resources to ensure that the best decision is being made at all times.

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When is it appropriate to opt for an indexed rate?

The decision to opt for an indexed rate depends on several factors that vary depending on the company's profile and needs. Here are some situations where an indexed rate might be the right option:

1. Companies with high energy consumption

For companies that consume a lot of energy, even small variations in the price of energy can have a significant impact on their costs. If your company has the ability to monitor the market and adjust its consumption according to conditions, an indexed rate could be beneficial.

2. Periods of low prices in the market

If energy prices in the wholesale market are expected to remain low for an extended period, an indexed rate could allow your company to take advantage of these conditions and save on costs.

3. Companies with experience in energy markets

Companies that have a team that understands the functioning of the energy market and can predict energy market trends can benefit from indexed rates. These companies can manage risks more effectively and maximize savings opportunities.

4. Risk management capacity

If your company has the ability to manage and mitigate the risks associated with market volatility, an indexed fee may be a viable option. This may include the use of financial hedging or long-term buying strategies.

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How to determine if you need an indexed rate for your company?

Before deciding on an indexed rate, it's crucial to do an in-depth analysis of your company's needs and capabilities. Here are some steps you can take to make an informed decision:

1. Analyze your consumption profile

Review your company's energy consumption history. Is consumption constant or does it vary depending on the season? Are there periods of high demand in which the price of energy could be critical? A detailed analysis of your consumption profile will help you understand if an indexed rate could benefit you.

2. Assess your risk tolerance

Consider how much risk your company is willing to take in terms of energy costs. If you prefer stability and predictability, a fixed rate might be more appropriate. On the other hand, if your company can handle uncertainty, an indexed rate could offer you savings opportunities.

3. Consult with energy experts

It is advisable to consult with an energy advisor or energy rate expert. They can help you understand market dynamics and provide you with a clearer view of the options available, as well as the potential risks and benefits.

4. Compare to other rate options

Don't just consider indexed rates. Compare this option with fixed rates and other modalities offered by retailers. This will give you a more complete overview of the available alternatives and will help you choose the best option.

5. Review the contractual conditions

Make sure you read and understand all the terms of the contract before opting for an indexed rate. This includes the margin that the marketer will apply, possible penalties for early cancellation and other relevant terms.

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Conclusion

Index rates can be an excellent option for certain companies, especially those that have high energy consumption and the ability to manage risks associated with market volatility.

The decision to choose an indexed rate depends on multiple factors, including your ability to manage risk and understand the complexities of the formulas applied by marketers. While indexed rates can offer savings opportunities, they also entail a high degree of uncertainty and lack of transparency in some cases.

What is clear is that not all indexed rates are the same and that simply analyzing a commercial margin is not enough to determine which one is the most suitable for your company. It's critical to understand all the costs involved and how they're calculated to make an informed decision. Therefore, before choosing an indexed rate, be sure to carefully analyze all the variables and, if necessary, seek specialized advice. In the end, choosing the right energy rate can have a significant impact on operating costs and the efficiency of your business.

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